Answers from the MMTers

By Stephanie Kelton and Randall Wray

A few days ago, Jared Bernstein posed some Questions for the MMTers in order to gain a “better understanding [of our] arguments.” We appreciate his interest in our ideas and, especially, his direct appeal for clarification of our views.  He raised four big questions, which our Australian counterpart, Bill Mitchell, has already answered in his own three-part series.  What follows is a response from two North American MMTers.

Jared: Overheating is possible, and taxing is a lousy mechanism for dealing with it.

We agree that relying on Congress to raise/lower taxes to fine-tune the economy will not succeed. We agree with Janet Yellen that stronger automatic stabilizers are needed to enhance cyclical stability, taking pressure off lawmakers (and the Fed) to be responsive to changing conditions in the economy. Having said that, we would note that our tax system is likely already too biased to pull in more revenue when the economy booms, as evidenced by the expansion-killing surplus during the Clinton years.

We would add, as Jamie Galbraith rightly argues, that overheating, while possible, hasn’t happened in at least two generations.  As Jamie says, “There hasn’t been inflation in the economy since the early 1980s. It collapsed with the end of the Soviet Union and with the rise of China as a supplier for consumer goods. So the Fed has been patting itself on the back for decades [of] holding back a phenomenon that doesn’t exist. [The Fed is like] the little Dutch boy with the finger in the dike who never troubles himself to look over the levy to see that the lake is dry.”  In other words, it’s been a couple of generations since the US economy experienced any significant inflation. Since then, inflation has become a highly global phenomenon.

We also note that neither mainstream academic economists nor the Fed itself have a robust theory of inflation. By contrast, the academic economists who created MMT have a long history of studying inflation and formulating policy to fight it should overheating ever become a problem. See, for example, Papdimitriou and Wray 1992, Bill Mitchell, and the new MMT textbook by Mitchell, Wray, and Watts.

In any case, relying on the Fed is the worst possible way to try to fight “overheating.” As the Bank of England has explained, central banks do not control the money supply nor do they have the tools to forcibly choke off an expansion of bank credit in order to fight inflation. The plain fact is that the Fed cannot “take money out of the economy”—as Jared presumes—like some kind of pickpocket rifling through our jeans in the dark of night. It relies on the overnight interbank lending rate (fed funds rate) as a policy instrument. It can take excess reserves out of banks (or put them into banks—e.g. via Quantitative Easing), but this does not work like a brake pedal or a gas pedal on bank lending—which is how money gets into the economy. No central banker today believes she can “take money out of the economy” as Jared puts it.

While we will not go into it in detail here, we recommend a public option—called the Job Guarantee—in the job market at a base wage to anchor the currency, helping to stabilize its domestic value against inflationary/deflationary pressure as well as stabilizing its exchange value against other currencies. MMT has devoted thousands of pages of research and over a quarter of century to analyzing and reporting of the results. Indeed, we have completed a major study using conventional modeling techniques that shows that a universal job guarantee program would provide true full employment while actually moderating inflation.

Finally, we remind Jared that contractionary fiscal policy (tax hikes or spending cuts) is presented in standard macro textbooks (of the Keynesian variety) as the appropriate way to deal with an overheating economy.  In other words, there is no daylight between Functional Finance/MMTers and conventional Keynesian theory when it comes to the idea of raising taxes to counter overheating.  Nowhere in the mainstream discussion of the Keynesian approach is there handwringing about the politics involved in getting a political body (Parliament, Congress, etc.) to carry out the fiscal tightening needed to curb inflationary pressure.  Hence, Jared is not really raising a critique of MMT at all—but rather is critiquing long-standing advocacy of use of fiscal policy that has appeared in every “Keynesian” macro textbook published since WWII.

Jared: What about the Fed? The central bank introduces another piece of the MMT framework about which I’m confused. Suppose, even if the economy is below potential, the Fed decides it doesn’t like all this money-printing and deficit spending advocated by MMTers.

First, let’s be clear: The Fed cannot ‘Just Say No’ to Congress. As Bernanke said, “We’ll do whatever Congress tells us to do.” And when it comes to deficit spending, the Fed works hand-in-glove with Treasury, coordinating operations to ensure a) payments always clear and b) bond auctions never fail. Its “independence” is actually limited to Congress’s willingness to let it set the overnight interest rate (which can be revoked if Congress decides to do so—as it did during both World Wars). See here for further elaboration. Neither the Fed nor any other country with control of its own central bank has ever bounced its own treasury’s check—and none of them will ever do so. Just listen to this panel of financial market experts, including Glen Hadden, former head of interest-rate trading at Morgan Stanley, if you doubt whether MMT has this right.

Yes, the Fed could decide to hike rates to fight against expansionary fiscal policy. But it would not do so in order to teach Congress a lesson. The Fed has a dual-mandate, and it will not raise rates sharply in the absence of credible evidence that inflation is poised to accelerate. All the money-financed deficit spending in the world won’t provoke the Fed if inflation is subdued. And the explicit goal of Functional Finance/MMT is to allow the budget deficit to fluctuate, as needed, to maintain full employment and price stability. Why would the Fed fight its own dual mandate?  Far better to sit back and take credit.

The bottom line is that the Fed does not have veto rights over Congress.  We rest assured by the twin facts that a) the Fed is a creature of Congress and can be brought to heel should that become necessary, and b) that the exigencies of providing a smoothly functioning payments system leaves no room for the Fed to veto the Congressionally-approved budget under which the Administration operates.

Jared: Krugman’s “finance-ability” point: Krugman argues that self-financing is more inflationary that bond issuance, but he’s not making the above points about MMTs flawed (IMO) assumption that tax cuts could handily deal with accelerating prices. He’s worried about currency debasing:

We can address this one very quickly.  The Krugman point you raise is from 2011. Scott Fullwiler addressed it back then.  But it hardly seems relevant any longer, given that Krugman has since recognized that it makes no difference, economically, whether deficits are bond-financed or money-financed.  And if it makes no difference, then either both risk debasement or neither does. As Kelton and Fullwiler explained in a Financial Times Alphaville blog, the only possible difference is political, and on that front money-financed deficit spending wins out because budget deficits no longer add to the national debt. With respect to “finance-ability” and the idea that investors could somehow prevent the government from accessing the bond market, except at a punishing premium, we refer you back to the link above, featuring Glen Hadden and Amar Reganti, former Deputy Director of the Office of Debt Management at Treasury or to remarks by former Undersecretary of the Treasury Secretary, Frank Newman.  It is not enough to hand-wave a conclusion that money-financed deficits will lead to currency debasement or risk a sharp rebuke from investors. You need to be able to demonstrate, operationally, why those might be legitimate risks.  Close study of the monetary operations, confirmed by experts in the field, suggests the MMTers have this right.

Jared: Timing issues re revenue raising vs. printing money: A theme of my work, to which MMTers often object, I think, is that we need to raise more revenues to pay for public goods. I recently wrote, for example, that, given our aging population, it will take something like 3% more of GDP to meet our obligations to Social Security and Medicare/Medicaid by 2035. MMTers push back that as long as we’re below potential, we can print the money to support government spending, so stop getting so wound up about “payfors.”

Even Alan Greenspan’s testimony about the long-run implications of an aging population rightly rejected any possibility that government might “run out of money.” Government can and will make all payments as they come due.

In truth, budget deficits are always ex post (the difference between spending (G) and tax receipts (T) cannot be known until after that year’s spending and taxing has taken place). There are three sectoral balances: a domestic private sector, a government sector, and a foreign sector. While any one of these can run a deficit (or surplus), the sum of the balances must sum to zero—that is, they balance (for every deficit there is a surplus). In the US, the private sector almost always runs a surplus (“saves”) and the foreign sector has run persistent surpluses (the other side of the coin to our current account deficits) since the days of Reagan. That means—by simple identity—that our government sector runs deficits.

This actually has been the norm since the founding of the nation over 225 years ago. Government deficits will continue to occur so long as the sum of the private and foreign balances are positive. While almost universally feared, government deficits are actually the source of the positive net balances in our household and business sector. While our generation today cannot dictate or even influence what the government’s balance will look like 30 years down the road, we can safely predict that it will be in deficit. If critics of MMT would study the work of Wynne Godley they would understand this.

Given aging, we need to shift 3% more of GDP to elderly over the coming decades. However, this will be done at the time we want to achieve the shift and it will be done through a combination of taxes on those of working age and spending on those of retirement age. This has nothing to do with deficits in those years (it will need to occur whether or not there are budget deficits or surpluses then)—and neither deficits nor surpluses today will either enable or constrain those deficits in the future should they occur.

Only someone who is confused about simple aggregate accounting would think that it is proper to tighten the fiscal stance today in order to “keep the powder dry” for use later as the fuel to support deficits to deal with the problems of aging. The best way to prepare for an aging society is to start building the infrastructure, the care system, and the know-how we will need to take care of tomorrow’s seniors.